Measuring Unilateral Market Power in Wholesale Electricity Markets: The California Market, 1998–2000

This paper measures the unilateral incentive each of the five largest electricity suppliers in California had to exercise market power in the state’s wholesale market during the four-month period from 1 June to 30 September of 1998, 1999, and 2000. Using the actual bids submitted to the California Independent System Operator’s (CAISO) real-time energy market, I compute the hourly price elasticity of the ex post residual demand curve faced by each supplier evaluated at the market-clearing price for that hour. The inverse of this hourly ex post residual demand elasticity quantifies the extent to which that supplier is able to raise the hourly real-time energy price above its marginal cost of supplying the last megawatt-hour (MWh) it sells in the CAISO’s real-time energy market. I use the average hourly value of the inverse of the firmlevel residual demand elasticity over the period 1 June to 30 September of each year as a summary measure of the extent of unilateral market power possessed by each supplier. For each firm, this measure of unilateral market power is significantly higher in 2000 relative to the corresponding firm-level values in 1998 and 1999. For each of the five firms, this measure is slightly higher in 1998 than 1999. Severin Borenstein et al. (2002) (hereafter BBW) report quantitatively similar results across these three years for their market-level measures of the amount market power exercised in the California market. The average value of their marketlevel measure was significantly higher during 2000 than in either 1998 or 1999, and the average value in 1998 was slightly higher than the average value in 1999. The firm-level results presented below are consistent with the view that the enormous increase in the amount of market power exercised in the California market beginning in June of 2000 documented in BBW was due to a substantial increase in the amount of unilateral market power possessed by each of the five large suppliers in California. The many investigations of the causes of the California Electricity Crisis currently underway have not uncovered evidence that suggests suppliers coordinated their actions to raise prices in California. The firmlevel measures of market power presented below indicate that coordinated actions by suppliers were unnecessary to bring about the substantial price increases that occurred during the period from 1 June 2000 to 30 September 2000. My results are consistent with these price increases in the CAISO’s real-time market being the result of the expected profit-maximizing response of each of the five suppliers to the bidding behavior of all other market participants in the California market.